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Credit cards are a way to borrow money to cover everyday purchases and bills. Different credit cards come with different interest rates and benefits so it is important to understand how they work and how you might find the most suitable credit card for you.


What is a Credit Card?

A credit card is a small card made out of metal or plastic that can be used to make purchases, pay bills or withdraw money. The credit on the card is essentially borrowed funds; it is money that you are borrowing in the short-term and paying off at a later date.

When you take out a credit card, your credit card will give you a monthly credit limit which is the amount of money you are allowed to use to make purchases or pay bills.

As you use your card for different payments, the available credit is reduced. Then on a set date, usually the end of the month, you will pay the credit card company back what you have spent out of your credit limit.



Key Features

Credit Limit $100 to $1 million (or more)
Interest Rates 0% to 30% APR
Annual Fees $0 to $200
Bad Credit OK Yes
Minimum Payments Required 10%
Balance Transfer Options Yes
Repayment Period 30 days


Credit Card Payment Example:

You get a new credit card and based on your income and affordability you are given a monthly credit limit of $2,000.

You use your new card to buy things online, go to restaurants and for travel. Your monthly bill comes to $1,500. If you pay this off in full after 30 days (when you bill comes in), it is free of interest and will not cost you anything.

If you are late paying your credit card bill, you will be charged an interest rate advertised, which could be up to 30% APR. You can also make a minimum payment of 10% of the bill without incurring fees, however, this debt will still be outstanding and it could negatively impact your credit score.


How Do Credit Cards Work?

The majority of credit cards can be used online, in store or to pay bills. Whatever you are using it for, the card details will be sent to the merchant’s bank. In order to process the transaction, the bank will receive authorization from the credit card network. Your card issuer will then have to verify your information in order to approve or decline the transaction.

For successful transactions, payments will be made to the merchant and your card’s available credit will be reduced by the amount of the transaction.

At the end of the billing cycle, this transaction will appear, along with any other transactions, your previous balance, your new balance, the minimum payment due and the due date.


What is a Credit Card Grace Period?

The grace period is the duration of time between the date of your credit card purchase and the due date that is specified on your statement. If you pay your bill in full on or before the due date, no interest charges will be accrued.

If you carry a balance at the end of your billing cycle, your card issue is entitled to charge you interest. This will be the APR: the cost of carrying a balance calculated on an annualized basis. The APR includes not only the interest rate, but any other relevant fees.

The majority of credit cards will have an APR that is variable and linked to the Prime Rate; this means that it will fluctuate over time.


What is The Difference Between a Credit Card and a Debit Card?

Credit cards can also be viewed as a form of short-term loan. They offer an amount of credit that can be used to make purchases, pay bills or withdraw cash. Then, in the future, you will need to pay back the loan amount at the end of the billing cycle. In order to avoid interest charges, you should pay back the full balance for purchases on the date specified. You will need to pay back at least the minimum payment each month by the balance due date.

Debit cards, on the other hand, offer a way of making payments or withdrawing money directly from your checking account. The money is not a loan and there is no need to make any minimum monthly payments; you will also not be charged interest for a debit card. However, you will only be able to spend the available money in your checking account.


How Do Credit Card Fees Work?

Some credit cards are free to use and have no annual fee, only taking fees if you are late or defer payment.

Other credit cards have an annual fee such as Capital One ($95), Chase ($95) or American Express ($200) and this may come with benefits such as air miles, points or additional rewards.

This fee amount will depend on the card company and will also be impacted by an introductory period. Some cards offer an introductory period meaning zero interest or low interest for a fixed period of time when you first open your credit card account.

There are additional fees incurred if you make a late payment. Other services that may incur fees include things such as drawing money at an ATM cash advances, foreign transactions or balance transfer fees, but this will depend on the card provider.

Unlike credit cards, debit cards do not typically charge annual fees. If there are insufficient funds in the checking account, it is possible that the debit card will carry overdraft fees. However, three are no monthly payments and subsequently no late fees, as there are with credit cards.


How Credit Cards Can Impact Your Credit Score?

Credit cards can be used to build your credit score as regular, timely payments will be reported to credit reporting agencies by your credit card issuer. This means that every timely payment is positively contributing to your credit score. If you regularly use your credit card and pay back the balance on the assigned debt, you are building credit and demonstrating to lenders that you can responsibly manage money. All of this will serve you well if you are applying for loans, mortgages or other credit in the future.


How Can Credit Cards Help To Manage Finances?

Using your credit card responsibly will help to lower your credit utilization rate. That is, by regularly paying off your credit card debt on time, you are reducing the amount of debt that you owe. The better your credit utilization rate, or debt-to-income ratio, the more desirable a candidate you will be for being approved for future loans or credit.


How Can I Increase My Credit Limit?

You can ask for a credit limit increase from your card provider whenever you want. Usually you need to have your new card for at least 3 to 6 months and get used to making payments on time for them to consider you for an increase, since this will be build trust with the provider. You may have an increase in income or expenses and therefore request a higher limit. The decision for a credit limit is often instant and the lender can tell you there and then when you log in online what your limit can be increased to. But they can also say no, which is common.


What To Look For When Comparing Credit Cards

If you are looking to take out a credit card, there are many different options available on the market. When shopping around, here are a few key points to consider:

  • Annual fees
  • Regular variable APR for purchases
  • APR for balance transfers
  • APR for cash advances
  • Rewards or points programs
  • Introductory offers

In addition to looking at fees or interest rates, it is worth looking at any offers or benefits. For example, frequent fliers can earn points for flights or hotels. You should also look at whether places where you regularly shop are associated with any particular card.

Richard Allan

Richard Allan

Richard Allan is the founder of Capital Bean and a passionate writer about personal finance, budgeting and how to save money at home and work.

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